October 2007

Supreme Court Overrules Ban On Minimum Price Agreements

Manufacturers invest substantial time and money building their products' brands and reputations among consumers. They often encourage retailers carrying their products to contribute to these brand-building efforts through co-operative advertising, promotions, in-store displays, customer service programs, and other efforts. High-service retailers, however, may be discouraged from doing their part if others, like Internet resellers, who do not make such investments, take business away from the high-service retailers by selling the same products at deep discounts. One way for a brand owner to avoid this problem is to set minimum resale prices. A recent United States Supreme Court decision makes it substantially easier for a manufacturer to do just that, with reduced risk of antitrust liability.

The Supreme Court recently overruled the longstanding rule that a manufacturer can never directly agree with a distributor to set a minimum price that the distributor can charge for the manufacturer's products. In Leegin Creative Leather Products, Inc. v. PSKS, Inc., the Supreme Court ordered lower courts to evaluate these minimum pricing agreements (or vertical price restraints) according to the "rule of reason" rather than strictly prohibiting such agreements. Under the new ruling, agreements that courts decide serve a pro-competitive purpose do not violate federal antitrust law. The Court's 5-4 decision, intended to bring the law into step with the thinking of today's economists, clears up years of seemingly contradictory precedent and confusing legal loopholes. Still, it remains to be seen how lower courts will determine when minimum pricing agreements will be permitted.

To appreciate the significance of the Supreme Court's decision, one must examine the legal history of vertical price restraints. The Court first banned them in 1911 in Dr. Miles Medical Co. v. John D. Park & Sons Co. It soon began cutting back on Dr. Miles, holding in 1918 that the ban on vertical price restraints was inapplicable to "unilateral" restraints not involving an agreement between a manufacturer and distributor. For example, a manufacturer could set a suggested retail price for its product and refuse to deal with distributors who sold below that price. This distinction led to much confusion for manufacturers seeking to set unilateral restraints. Could a manufacturer answer a distributor's questions about unilateral price policies without creating the appearance of an agreement? Could a manufacturer resume selling to a distributor that decided to comply with pricing requirements after initially refusing?

The Leegin Court concluded the ban on vertical price restraints had become "a flawed antitrust doctrine that serves the interests of lawyers - by creating legal distinctions that operate as traps for the unwary - more than the interest of consumers - by requiring manufacturers to choose second-best options to achieve sound business objectives."

The Leegin Court did not set out rigid instructions for lower courts to follow in deciding whether a particular vertical price restraint is pro-competitive or anticompetitive. Instead, the Court stated that the lower courts "gain experience…over the course of decisions" that will assist them in developing workable guidelines. Nonetheless, the Court gave an overview of the desirable and undesirable potential effects of vertical price restraints, which could be helpful both to manufacturers and other brand owners in shaping a minimum pricing policy that is likely to be upheld, and to retailers seeking to challenge a minimum pricing policy as anticompetitive.

The Court focused on two pro-competitive effects of vertical price restraints. First, the restraints help eliminate the problem of "free riders" or low-service retailers who benefit from the demand for certain products created by high-service retailers who spend money promoting the product and building its reputation. Further, if retailers cannot compete with each other on price, they will instead compete on services, thereby creating higher quality retailers. Second, vertical price restraints can stimulate competition among retailers selling different brands of the same type of product by reducing competition among retailers selling the same brand. This provides additional incentive for retailers to invest money in services and promotional efforts that help manufacturers - particularly new manufacturers seeking to enter the market - boost their products' reputation and brand recognition.

As for anticompetitive effects, the Court focused on the potential for abuse of vertical price restraints by those seeking to set up "cartels" or groups of manufacturers or retailers of a similar product formed to regulate prices and obtain a monopoly over the sale of the product. Cartels, the Court explained, do not promote competition among brands or give retailers an incentive to provide more services, but instead allow inefficient cartel members to prevent retailers with lower cost structures from competing on price. The Court noted vertical price restraints can be abused by a powerful retailer who pressures a manufacturer into adopting a minimum price by threatening not to distribute and carry its product. But a powerful manufacturer could use vertical price restraints to give retailers an incentive not to sell its competitors' lower priced products.

It is highly possible that varied and unpredictable judicial decisions will follow as courts flesh out Leegin and apply its teachings to different factual situations. Therefore, it may be advisable for manufacturers to wait for courts to develop clearer guidelines before establishing vertical price restraints. Still, the Court provides some insights that may be helpful to those considering instituting vertical price restraints.

• Consider industry norms before setting minimum prices.
  The Leegin Court noted that "the number of manufacturers that make use of [vertical price restraints] in a given industry can provide important instruction" to lower courts in determining whether the practice is pro or anti-competitive. The Court explained, "When only a few manufacturers lacking market power adopt the practice, there is little likelihood that it is facilitating a manufacturing cartel, for a cartel then can be undercut by rival manufacturers."
• Do not set minimum prices at the request of retailers or distributors.
  Retailers should avoid requesting that manufacturers institute vertical price restraints, and manufacturers should reject any such requests from retailers. "If there is evidence retailers were the impetus for a vertical price restraint, there is a greater likelihood that the restraint facilitates a retailer cartel or supports a dominant, inefficient retailer."
• Do not discuss minimum pricing programs with competitors.
  While a manufacturer can now communicate its minimum pricing requirements to its distributors and retailers, groups of manufacturers or retailers may not effect any agreement regarding pricing. Manufacturers should communicate minimum pricing plans to each of their retailers individually and discourage retailers from discussing the plan with one another in order to avoid the appearance of an illegal retailer cartel.
• Consider setting minimum prices unilaterally.
  Remember even before Leegin, manufacturers could unilaterally set minimum resale prices and refuse to sell to retailers who advertised or sold below them. This approach may satisfy some manufacturers. Thus, instead of forming unnecessary minimum pricing agreements with retailers, manufacturers may continue announcing unilateral minimum resale price policies and avoid communications with retailers about pricing that might be considered an unlawful "agreement."

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